Schubert, Jonckheer, & Kolbe, LLP; Johnson & Weaver, LLP; Bronstein, Gewirtz, & Grossman, LLC; Levi & Korsinsky; and Wohl & Fruchter, LLP have all announced they are actively investigating whether executives and shareholders including CEO Mark Pincus breached their fiduciary duty and broke securities law in selling over $500 million worth of stock in a secondary stock offering this April. In selling that stock at $12 a share—well above the current $3 share price brought on by the weak earnings report—the executives allegedly "misrepresented and/or failed to disclose materially adverse facts about its business and financial condition." In other words, they knew this was coming, and they sold their own interests rather than warning the general shareholders.

Besides CEO Mark Pincus, the list of major shareholders that sold off part of their interest in the company in April includes COO John Schappert and CFO Dave Wehner, venture capital firms Venture Partners, Silver Lake Partners, and Union Square Ventures, and even Google, which was revealed as an early Zynga investor during the latter company's IPO.

Simply selling the stock isn't proof of wrongdoing, of course—the law firms are going to have to prove that the sales came because of insider knowledge that the business was doing worse than it seemed to the outside world. It's hard to believe that the Zynga executives didn't have some inkling that their upcoming earnings report was going to come in well below expectations, but what they knew and when they knew it will be key to any legal ruling.

While Zynga hasn't technically been sued yet, the number of lawyers on the scent of this case makes it exceedingly likely that it will be the subject of a class-action lawsuit from its shareholders in the near future. That might be the best way that shareholders can get their voices heard on the matter—Zynga is somewhat notorious as one of the few companies where regular investors have next to no say in how the company is run.

Not to defend Zynga, but this sort of "Dewey, Cheatem & Howe announce they are investigating Acme LLC and invite any concerned shareholders..." play is incredibly common after the announcement of down quarters, mergers, etc.

I've always stood by my hate for Zynga and its brand of "social" gaming. The only thing social about it was spamming people's walls so I never understood the hype.

Analysts were hyping this stock up forever; it's embarrassing to read their feigned surprise at these events. A little bit infuriating at the same time since many (especially gamers) were critical of Zynga long before. Zynga got the ball rolling but the analysts kept pushing it.

There was also plenty of skepticism out there on the comment sections here at ars, gamasutra, NeoGAF, etc. It's a shame it didn't traverse over to the investment realm where it actually mattered. I still don't really feel bad for anyone who invested in the company. I mean look at the first comment regarding Zynga's overvaluation on this old Gamasutra article from 2010:

"5.51 billion dollars, just for a company that sells virtual goods? Sounds pretty unsustainable to me."

A lot of people responded and gave that guy shit but he called it right. What's crazy is some of us thought that $5.5 billion number sounded too high back then but I think it was at $7 billion when it actually went public.

Hmm... well, I'm gonna chime in and may get flamed but I'll play the devils advocate, and the key phrase is 'what they knew, and when they knew it'. If you built a company from the ground up, put your money into it, had it become amazingly popular, went public, saw the stock price rise above anything you could expect to reasonably get... and you had a bunch of stock...

Wouldn't you cash out?

These stock trades happened 90 days ago (roughly) and in the space of 90 days, a LOT can happen, especially in the social media scene. Just think MySpace - how quickly did that turn into a barren wasteland? Were there SEC investigations there?

As someone mentioned above, just because we have lawyers 'announcing an investigation' does NOT mean that they are doing anything but trolling for plaintiffs (it still infuriates me when I see all those damn "have you been injured in an accident" commercials), and it certainly doesn't mean that the owners have necessarily done anything wrong.

Hell, if someone offered me 4 times what my business is worth, I'd be retired somewhere pleasant with my gf in a bikini on a beach somewhere. The first words out of my mouth would be "where do I sign".

It didn't take insider information to know that zynga wasn't going to do well. If you based whether or not to keep your stock in zynga on frequency of mention in news articles, number of games released, general popularity of games on facebook, you would have sold all your stock in ~ April. People playing the stock market seem to be exceedingly blind when it comes to nuances of technology that signal success/failure, much less the lazy assholes that listen to a friend of a friend on the next big thing. It is all just a form of gambling that is slower than playing poker. It may be suspicious that he cashed out when it was high, but then again, selling high and buying low is exactly how you play the game.

Hmm... well, I'm gonna chime in and may get flamed but I'll play the devils advocate, and the key phrase is 'what they knew, and when they knew it'. If you built a company from the ground up, put your money into it, had it become amazingly popular, went public, saw the stock price rise above anything you could expect to reasonably get... and you had a bunch of stock...

Wouldn't you cash out?

Not in the manner they did. Pincus sold something like 20% of his holding in a very short-time. A CEO who believes that his company will grow (hence the reason for IPO) should never sell that much stake that fast. Add that to the fact that their employees were screwed to prop up the IPO price... yeah not shady at all.

Also, a common myth is that IPO is the only way to "cash out" for founders. Not so. You can always get your company acquired, or sell your own stake through 2nd hand market. You might not get as much as hyped up IPO, but you can still make a tidy sum.

Rookie_MIB wrote:

These stock trades happened 90 days ago (roughly) and in the space of 90 days, a LOT can happen, especially in the social media scene. Just think MySpace - how quickly did that turn into a barren wasteland? Were there SEC investigations there?

Myspace screwed itself over many months with many decisions. Also it was under a perfect storm when it happened. Anyway, your point is contradictory in itself. You're telling me that the Execs aren't competent enough to give useful guidance to shareholders about their business over a relatively short period of time, yet deserve hundreds of millions of compensation for their "business insights".

Rookie_MIB wrote:

As someone mentioned above, just because we have lawyers 'announcing an investigation' does NOT mean that they are doing anything but trolling for plaintiffs (it still infuriates me when I see all those damn "have you been injured in an accident" commercials), and it certainly doesn't mean that the owners have necessarily done anything wrong.

What if they already have few plaintiffs? Getting class-action status gives you some advantage, so why not? There's nothing "wrong" with that either.

Rookie_MIB wrote:

Hell, if someone offered me 4 times what my business is worth, I'd be retired somewhere pleasant with my gf in a bikini on a beach somewhere. The first words out of my mouth would be "where do I sign".

Except no one will offer you that, unless your business will be worth 4*X in Y years, where X is bigger than 2 and Y is preferably less than 10. That's what an IPO is. You tell/lie to the public that your company will grow many times bigger than it currently is, if you give them some cash to do it.

These stock trades happened 90 days ago (roughly) and in the space of 90 days, a LOT can happen, especially in the social media scene. Just think MySpace - how quickly did that turn into a barren wasteland? Were there SEC investigations there?

Haven't these guys been bragging about how many metrics they collect and analyze to squeeze every last bit out of their products? You'd think with that kind of data they could see something like this coming. Oh, wait...

You know, Pincus's name is one letter off from the Roman god Picus, the god of Bull Poop. Coincidence? I think not.

The problem with investing in the stock market on the "Next Big Thing" is that it has a way of transforming into becoming the "Next Big Sucker's Bet". This has happened with so many businesses it isn't even funny.

The shenannigens that seem to be implied here is that they knew this was a sinking ship and the rats already made sure they had their life vests and life boats at the ready. Too bad it seems that said vests and boats might have a few holes in them if the investigation turns up anything suspicious.

Not to defend Zynga, but this sort of "Dewey, Cheatem & Howe announce they are investigating Acme LLC and invite any concerned shareholders..." play is incredibly common after the announcement of down quarters, mergers, etc.

They're trolling for plaintiffs.

This. Pincus is scum but the lawyers involved here are even worse. And yes, every time a stock takes a significant dive, lawsuits will be filed. I don't know if it even qualifies as news.

Try this: YouTube. Enter "Mark Pincus, Zynga" into the search box. Press enter. Enable your "Violent Response From Being Totally Pissed Off Blocker". Mark Pincus is an expert at sleazebag. He could get rich teaching a college class, or learn at home software.

Honestly, anyone who was dumb enough to invest in Zynga is getting what they deserve.

Not really, I made a nice bundle on it over time.

If you traded it instead of holding it long Zynga was a cash cow.

So, you didn't "invest in it."

Sure I did, investing is investing, period, the goal of investing is to get a return on your money. Any savvy investor knows that you always take profits when they are available and suitable to their investing plan. I held the core amount I originally purchased for a while in case of a big price spike and over time bought and sold others in day trading. By doing that I got the money back that I spent on the core amount so there was no loss there, and maintained a fairly steady growing profit from the rest of the buys and sells in day trading and accumulated as well adding to the original core amount. Basically everything I bought and sold in day trading was paid for out of the profit so I got my money back on those day traded as well and kept my exposure slim to none. April came around and I sold off the original core amount plus those accumulated. Planning, timing, execution, trading, and from lessons learned a long time ago - its called stock trading and not stock keeping for a reason.

How are they going to prove insider trading weighed more in their decision making than the blindingly obvious fact they didn't have a business model?

You don't need a business model. All you need is something to offer product wise, people willing to pay for it, and investors. There is no law or requirement that a company have a certain business model, only that it obey the law in doing business, accounting practices, fiduciary duty, issuing stock, and for company execs/officers - how and when they sell their stock.

Business model or not has no bearing on insider trading. These law firms claim they allegedly breached their fiduciary duty and broke securities law by using insider knowledge of upcoming poor earnings to sell stock ahead of the poor earnings being made public. The law firms are not claiming they did not have a business model. Fiduciary duty and adhering to securities law is an entirely seperate and distinct thing from a business model, and one has no bearing on the other. Insider trading is suspected and claimed a lot more often than it actually exists or is proven.

One of the law firms soliciting for investors to contact them, http://www.faruqilaw.com/ZNGA, gives a clue as to what they are really interested in and that is losses of $100,000.00 or more. Soliciting for high loss investors like that is usually prelude to a law firm trying to create a lawsuit of some sort, most times they go no where but are a lot of times created with the hopes of having a company settle even if they did nothing wrong to avoid having assets frozen or paying massive amounts of legal fees in defense. If a class action, the ones with the most loss come into the suit first, after filing the court decides if it should be a class action. Its those with the bigger losses that were first in the suit and their attorneys that get the largest share of proceeds in the event of a settlement or award. Scraps left after that are picked over and distributed to the remaining members of the class that were included after the ones with the biggest losses bought suit. So this "investigating" thing looks like nothing other than wanting to get a law suit going because some high rollers lost money. Going straight to a law suit usually means they don't have the evidence needed to get the SEC or DOJ involved, they go to a law suit to get the court behind them so they can subponea and freeze assets then they draw it out as long as possible till the company gives in and agrees to a settlement just so they can get their assets unfrozen (if frozen), avoid increasing legal fees, and continue business or their lives. It could also be the law firms are posturing in hopes of getting the company to settle with the high rollers outside of court and the law firms get a large fee from the high rollers or paid by the company.

Investors who went long in this should have known better. The IPO said it all, there were three classes of stock, the class A common stock issued to public investors carried a 1.8% voting right which should have told investors the company was controlled and there were no checks and balances available to public shareholders. Another warning sign was the other two classes of stock, class B and C, had 98% of the voting power. Another warning sign, the valuation - give me a break for cripes sake, there is no true valuation here worth what they said it was. Any time the primary vehicle of valuation expression is public sentiment hype on the internet with a controlled company its time to look elsewhere for long term investment. This was a stock to play, not for long term investment, all the signs were there. Although I did not short it, it was sort of a shorters wet dream come true.

The big clue, in case it was missed, is in the secondary stock offering. Why was a secondary stock offering made only a few months after the IPO? Thats what raised a red flag, i've no doubt there were a lot of people wondering the same thing. A lot of companies do not produce their earnings report until its almost due, the figures may not be known until its too late, so its possible they sold shares without knowing of the bad figures at the time and just sold into the second offering. Its also possible they set up the second offering specifically for dumping shares because they knew of the poor earnings (which I kind of doubt).

Could be any number of things involved for the secondary offering, I think its more possible a lock-up period ended which allowed them to legally sell their lock-up eligible shares following an IPO. One legal reason for a secondary offering is so lock-up shares can be sold. Not sure what the exact lock-up period was in this case but a lock-up is generally at least 90 to 180 days, I tend to think maybe 90 days at least for the execs in this case. The IPO was in December 2011, If they sold eligible lock-up shares into the secondary offering it did not matter if they knew of poor earnings because they could still sell those shares legally without informing the public of poor earnings. I know when the secondary offering was announced, the reason given for the offering by ZNGA was they were trying to manage the lock-up period for employees that could negatively affect the company’s share price. The company said it was doing this to “facilitate an orderly distribution of shares and to increase the company’s public float,” (which is what one legal reasoning for a secondary offering is supposed to do) basically trying to avoid a situation that has happened to other companies with initial public offerings where employees would dump stock all at the same time and share prices would plummet as a result. Zynga’s plan gave investors and company executives a legal way to liquidate early. Although contested by some, and distasteful to some shareholders, this strategy is a legal acceptable main reason for a secondary offering. The company gave a pricing of $12 per share for 42,969,153 shares when they announced the secondary offering, this is the number of eligible lock-up shares totaled from the execs selling into the offering. This is the reason the price went to $12.00 so it was not falsely or deceptively inflated because it was specifically announced to be that price and a company is legally free to set the price of shares offered in such offerings, price announced and lock-up shares sold and got $515,629,836.00 from the sell of those lock-up shares. So if the plan was legal and only eligible lock-up's sold then everything is legal here and there was no insider trading, breached fiduciary duty, or securities law violation. Who knows at this point, no one can say for sure yet.

Kyle Orland / Kyle is the Senior Gaming Editor at Ars Technica, specializing in video game hardware and software. He has journalism and computer science degrees from University of Maryland. He is based in the Washington, DC area.